Vehicle warranties

Is a vehicle warranty assurance-type or service-type?

IFRS 15 separates warranties that only assure the vehicle complies with agreed specifications from those that also give the customer a service. Factors include whether the warranty is required by law, how long the coverage is compared with what is normal in the market, and what the carmaker promises to do. A three-year warranty in a market where three years is standard is assurance-type. A warranty the customer can buy separately is always a service. Coverage well beyond the market norm, roadside assistance or free scheduled maintenance included in the price are services, so part of the vehicle price is allocated to them. See performance obligations.

Vehicle warranties: building and using the provision

A carmaker sells 100,000 vehicles with a three-year standard warranty. Claims history for similar models shows an expected cost of US$ 300 per vehicle over the warranty period, with 20% of claims in the first year, 35% in the second and 45% in the third. At the time of sale, it recognises a provision of 30 million and an equal cost of sales.

The provision is measured at the best estimate of the cost to settle the obligation, including parts, labour and the dealer's handling fees, and discounted where the effect is material, which matters more for long warranties. If claims run ahead of expectations, for example because of a defective component, the carmaker increases the provision for vehicles already sold and recognises the increase in profit or loss in that period. Estimates are made by model and model year, because a new model has little history.

How are extended warranties accounted for?

An extended warranty sold for US$ 1,200, covering years four and five after the standard warranty expires, is a service: the 1,200 is a contract liability until coverage starts and is then recognised over the 2 years, evenly or in line with the expected pattern of claims if that differs significantly. The costs of repairs under it are expensed as incurred, not provided for, because they relate to a service still being provided. If the contract is expected to cost more than it earns, an onerous contract provision is needed. When a third party underwrites the extended warranty and the carmaker or dealer only sells it, the seller is an agent and recognises a commission. See car dealer revenue.

How are recoveries from suppliers treated?

When a supplier's part is defective, the carmaker can often recover part of the warranty cost from the supplier. IAS 37 recognises a reimbursement only when it is virtually certain to be received, and as a separate asset, not netted against the provision. If the carmaker expects to recover 10% of costs but has no agreement yet, the full provision of 30 million stays and no asset is recognised until the supplier accepts the claim. In profit or loss, the expense can be presented net of the reimbursement once it is recognised. See IAS 37 provisions.

What about goodwill repairs and recalls?

Carmakers often repair faults just outside the warranty period as goodwill. If this is an established practice that customers have come to expect, it creates a constructive obligation, and the expected cost is included in the provision. Recalls and field campaigns to fix safety or emissions defects are provided for when the carmaker has a present obligation, legal or constructive, usually when it decides on or announces the recall, or when a regulator requires it; some carmakers also include an estimate of future campaigns in their warranty provisions based on history. Recalls are covered in a later guide.

How are warranty provisions presented and disclosed?

Warranty provisions are split between current and non-current, with the movements in the year, new provisions, amounts used, changes in estimates, discount unwinding and currency effects, disclosed in the provisions note. Because the estimates are significant, carmakers explain the assumptions and the sensitivity of the provision to claim rates. Suppliers that give warranties to carmakers on their components apply the same principles. See manufacturing warranties.

How does US GAAP differ?

Under US GAAP, standard warranties are accrued when the vehicle is sold under ASC 450 and ASC 460, and extended warranties are deferred and recognised over the coverage period under ASC 606, so the answers are similar. US GAAP requires a table reconciling the warranty liability each year. It also generally does not discount warranty provisions, while IFRS discounts where material. See IAS 37 vs ASC 450 and automotive accounting.

This guide is general information. It is not tax or legal advice for your situation.